Textbook vision of the role of finance: Textbook vision of the role of finance: Probably most workers instead view finance as: - creating employment risk via corporate restructuring, bankruptcies, and financial crises
- enabling or spurring firms to maximize share value at labor’s expenses
- allowing bankers to earn astronomical bonuses, etc.
The crisis has reinforced this negative vision of finance. Good time to think about this…
How does financial development (FD) affect employment, wage and productivity growth? How does it affect the variability of employment?
For a start, consider case of identical firms For a start, consider case of identical firms 1-size continuum of firms with Cobb-Douglas technology: Entrepreneur has wealth A He can “steal” (at most) fraction 1 of revenues (net of wages: no stealing from workers) Better investor protection more funding to firms (henceforth = degree of FD) Competitive credit and labor markets
FD raises the response of employment to changes in: FD raises the response of employment to changes in: - growth opportunities : firms can better exploit them hire more labor, offer higher wages
- initial cash flow A: it allows firms to lever more on its cash hire more labor, offer higher wages
This result hinges on firms being finance-constrained. True with CRS: firms always want to expand If there is an efficient scale K*, once firms are past K*: - effect of FD abates as economy grows
- FD no longer affects employment response to cash-flow shocks
We extend the approach by Rajan and Zingales (1998): FD should matter more for industries that are more “dependent on external finance” External dependence = reliance on external finance by U.S. listed companies in the Compustat database Baseline specification:
Value added, employment and wage bill (Yj c): UNIDO INDSTAT3 2006 database, 1970-2003 yearly data for - 28 three-digit-industries
- 63 countries
External dependence (EDj): Rajan and Zingales (1998) Financial development (FDc): - private credit/GDP
- stock market capitalization/GDP (1980–95 averages)
Extend model to 2 industries with different prospects: Extend model to 2 industries with different prospects: Labor flows freely between them: single equilibrium wage w Now FD affects not only total employment but also its distribution between industries – in favor of industry H ! With higher FD, industry H attracts more funds than L: - employment in industry H grows by more than in industry L
- employment in industry L may drop (if Ls is sufficiently inelastic)
- sufficiently high FD will eventually “shut off” industry L
With greater FD, sectoral growth shocks entail more cross-industry employment reallocations With greater FD, sectoral growth shocks entail more cross-industry employment reallocations But as FD proceeds, more and more firms achieve their efficient scale and become unconstrained: - these firms stop reacting to cash flow shocks…
As FD rises, it lowers the effect of cash flow shocks on job reallocations (eventually eliminates it)
Strategy: regress a measure of inter-industry reallocation on measures of - FD
- FD cross-industry dispersion of stock returns: FD should amplify response of sd to growth shocks but lower it to cash flow shocks
where sd = cross-industry st. dev. deviation of Yjct (industry j’s growth in VA, L or w) in country c and year t
FD may become a handicap in a crisis because they create “dependence”: the more financial markets are trusted in normal times, the greater the damage to output and employment when a crisis hits FD may become a handicap in a crisis because they create “dependence”: the more financial markets are trusted in normal times, the greater the damage to output and employment when a crisis hits Most clearly seen by looking at liquidity provision: in normal times banks allow firms to save on liquidity deploy more resources to production But when banks are hit by a liquidity shortage, the damage can be more severe
Two empirical strategies: Two empirical strategies: - Kroszner et al. (2007): re-estimate Rajan-Zingales regressions before, during and after a financial crisis:
- Panel data approach similar to Braun & Larrain (2005):
Financial crisis data from Laeven and Valencia (2010): universe of banking crises (1970-2009)
Financial development is associated with Financial development is associated with - more employment growth, but only in non-OECD countries
- less employment reallocation (cross-industry dispersion of employment growth)
- but more employment reallocation in response to greater variability of shocks to growth opportunities (cross-industry dispersion of stock returns)
Some evidence of a “dark side” of financial development: - during crises, employment growth drops more in financially dependent sectors of countries with more developed financial markets
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